The Great Liquidation begins: some will profit nicely and it won’t be you

By davidpetraitis, on November 23rd, 2010

Julie Cresweill in Dealbook has a report on the sales of troubled assets.

It is the biggest rummage sale in Wall Street history — what one investment company calls “the Great Liquidation.”

Two years after Washington rescued Wall Street, hundreds of billions of dollars of bad investments — in many cases, the same ones that poisoned banks and then the economy — are going up for sale.

The banks you will remember have a lot of this still on their balance sheets.

The nation’s banks are still sitting on hundreds of billions of dollars of mortgage- and real estate-related securities and loans. Despite the most sweeping overhaul of banking rules since the Depression, banks have taken a wait-and-see attitude toward adapting many of the new rules or offloading billions of dollars of troubled securities.

They were able through the the repeal (sorry “increased flexibility”) of the mark-to-market rules by FASB, which allows banks to keep these toxic loans on the books at a mark-to-make-believe number. All the while the industry, of course, could place the blame on our competent government representatives (as reported by MarketWatch):

Responding to pressure applied by lawmakers on Capitol Hill, the Financial Accounting Standards Board on Thursday [that was back on April 2, 2009 – dp] voted unanimously to give auditors more flexibility in valuing illiquid mortgage assets that may have long-term value.

What this did was buy time for the banks and financial institutions. But now the liquidation of assets (loans) on their balance sheets has begun, with hedge funds poised to price the assets in an illiquid, sometime shady market. And there is a lot of assets to change hands. Ms. Cresswell writes:

While banks need to purge themselves of troubled investments or drop profitable businesses they no longer want, the vast shadow financial system, which operates beyond the realm of traditional banks and banking regulators, could move deeper into the shadows if would-be buyers get their way.”

You’re going to see over the next five years, more financial asset liquidations than you’ve seen in the sum total of the last 100 years,” said Peter L. Briger Jr., who oversees $12.7 billion of credit-related private equity and hedge fund investments as co-chairman of the Fortress Investment Group….

Other investors are hunting for treasure, too, amid the wreckage of the financial crisis….

But as once-unloved assets land in the hands of less regulated entities, some wonder whether more, not less, risk is being introduced into the financial markets.

“Is the world a safer place? I’m not so sure,” said Ernest Patrikis, an insurance and banking regulatory lawyer with the firm White & Case. “There are really questions here of whether, through regulation, we’ve made a commercial banking system that is too riskless and put too much risk into the phantom banking system.”

But the profits motive still is king:

In still many other cases, there is a significant disconnect between what the banks are willing to sell the securities or loans at versus what hedge funds or private equity firms think they are worth.

Take, for instance, commercial real estate loans. The nation’s banks, from giants to tiny community banks, still hold nearly 45 percent, or $1.5 trillion, of commercial mortgage loans outstanding. Other institutions own the rest.

Many of those loans, analysts say, are hardly worth the paper they are written on.

Yet little of such troubled commercial real estate debt is being offered up in the market for sale, analysts say. That is because the banks are holding the debt on their balance sheets at prices much higher than what buyers are willing to pay. If the banks sell the loans for less than they are valued on their books, they will be forced to take write-downs against their losses.

Banks may have their commercial real estate assets or loans valued at 75 or 85 cents on the dollar, and hedge funds and others may be looking to buy closer to 30 or 40 cents on the dollar depending on the level of distress…

Just to think about it a bit, the 50 percent difference (spread) in pricing between the banks and the hedgies translates to $750 billion, more or less depending how negotiations go. And with so much capital chasing existing commercial real estate, the building of new projects will remain at a very low level for a while.